A trio of professors working with the national Quality Research Center at the University of Michigan finds that offshore outsourcing hurts customer service ratings, but farming out back office operations has a limited impact.

The working paper, conducted by the University of Michigan as well as Nasscom, India’s association of software and services companies, was penned by Jonathan Whitaker from the University of Richmond, M.S. Krishnan and Claes Fornell at the University of Michigan. The three outlined their findings in the Wall Street Journal on Monday, but the full working paper is worth a read.

The big takeaways from the study, which was based on the outsourcing activity of 150 North American firms between 1998 and 2006:

Offshore outsourcing front office functions like customer service leads to a significant decrease in customer satisfaction based on the American Consumer Satisfaction Index (ACSI). However, outsourcing customer service onshore also leads to a similar decrease. Lesson: Think really hard before farming out customer service. After all, the party you outsource to doesn’t have its company riding on the outcome.

“Back office offshoring is not associated with a change in customer satisfaction, it is associated with an increase in customer loyalty.” Lesson: Back office functions work behind the scenes and efficiency matters more than touchy feeling indicators.

The average ACSI decline from taking front office operations offshore was a drop of 1 percent to 5 percent of a company’s market cap. Lesson: Screw outsourcing up and your savings will be eclipsed by your declining market cap.

The authors are sure to note that the study’s findings shouldn’t push companies to ditch outsourcing–the savings are substantial–but firms need to make sure they take things offshore the right way. Obviously, picking the right corporate function to take offshore is critical. Another key thread: Make sure that companies give their customer service reps offshore enough information. Often, these offshore workers don’t have the full account history or profiles and lack authority to really solve the problem. Toss in language and cultural barriers and there’s a customer service trainwreck.

We find that offshoring front office functions is associated with a decrease in customer satisfaction. While offshoring back office functions is not associated with a change in customer satisfaction, it is associated with an increase in customer loyalty. Interestingly, while front office offshoring is associated with a decrease in customer satisfaction, onshore front office outsourcing is associated with a similar decrease. Additional analysis shows that front office offshoring and onshore front office outsourcing are both associated with a similar decrease in perceived quality, one of the primary determinants of customer satisfaction. Neither front office offshoring nor back office offshoring are associated with an increase in perceived value, another primary determinant of customer satisfaction, despite the fact that offshoring enables firms to reduce costs.

Here’s a look at the full results (click on the image for the larger version):

The big question here is why firms are increasingly outsourcing even when customer service falls. Are these companies trading off costs today for a revenue hit tomorrow? Possibly given that the weak dollar is eroding some savings of offshore outsourcing anyway. The paper notes that companies can reap benefits from outsourcing, but they have to execute well–and more importantly pick the best function to take offshore. Too often companies don’t do either.